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Introduction
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Costing
Introduction to Cost and Management Accounting
Costing:
Costing is defined as the technique and process of ascertaining costs.
There are many types of costs involved in cost accounting, which are defined below.

Types of Costs
i. Fixed Costs:
Fixed costs are costs that don't vary depending on the level of production. These are usually
things like the mortgage or lease payment on a building or a piece of equipment that
is depreciated at a fixed monthly rate. An increase or decrease in production levels would
cause no change in these costs.
ii. Variable Costs:
Variable costs are costs tied to a company's level of production. For example, a floral shop
ramping up their floral arrangement inventory for Valentine's Day will incur higher costs when
it purchases an increased number of flowers from the local nursery or garden centre.
iii. Operating Costs:
Operating costs are costs associated with the day-to-day operations of a business. These costs
can be either fixed or variable depending on the unique situation.
iv. Direct Costs:
Direct costs are costs specifically related to producing a product. If a coffee roaster spends
five hours roasting coffee, the direct costs of the finished product include the labour hours of
the roaster and the cost of the coffee beans.
v. Indirect Costs:
Indirect costs are costs that cannot be directly linked to a product. In the coffee roaster
example, the energy cost to heat the roaster would be indirect because it is inexact and
difficult to trace to individual products.

Cost Accounting:
Cost Accounting is classifying, recording an appropriate allocation of expenditure for the
determination of the costs of products or services, and for the presentation of suitably
arranged data for the purpose of control and guidance of management.
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It is the process of accounting for cost which begins with recording of income and expenditure
and ends with the preparation of statistical data.
It is the formal mechanism by means of which cost of products or services are ascertained
and controlled.
It provides analysis and classification of expenditure as will enable the total cost of any
particular unit of product / service to be ascertained with reasonable degree of accuracy and
at the same time to disclose exactly how such total cost is constituted.
It establishes budgets and standard costs and actual cost of operations, processes,
departments or products and the analysis of variances, profitability and social use of funds.
Thus, Cost Accounting is a quantitative method that collects, classifies, summarises and
interprets information for product costing, operation planning and control and decision
making.

Cost Accountancy:
It is defined as the application of Costing and Cost Accounting principles, methods and
techniques to the science, art and practice of cost control and the ascertainment of
profitability.
It includes the presentation of information derived there from for the purposes of managerial
decision making.
Thus, Cost Accountancy is the science, art and practice of a Cost Accountant.

Objectives of Cost Accounting

The following are the main objectives of Cost Accounting:
(a) To ascertain the Costs under different situations using different techniques and systems
of costing
(b) To determine the selling prices under different circumstances
(c) To determine and control efficiency by setting standards for Materials, Labour and
Overheads
(d) To determine the value of closing inventory for preparing financial statements of the
concern
(e) To provide a basis for operating policies which may be determination of Cost Volume
relationship, whether to close or operate at a loss, whether to manufacture or buy from
market, whether to continue the existing method of production or to replace it by a more
improved method of production....etc
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Scope of Cost Accountancy

The scope of Cost Accountancy is very wide and includes the following:
(a) Cost Ascertainment: The main objective of Cost Accounting is to find out the Cost of
product / services rendered with reasonable degree of accuracy.
(b) Cost Accounting: It is the process of Accounting for Cost which begins with recording of
expenditure and ends with preparation of statistical data.
(c) Cost Control: It is the process of regulating the action so as to keep the element of cost
within the set parameters.
(d) Cost Reports: This is the ultimate function of Cost Accounting. These reports are primarily
prepared for use by the management at different levels. Cost reports helps in planning and
control, performance appraisal and managerial decision making.
(e) Cost Audit: Cost Audit is the verification of correctness of Cost Accounts and check on the
adherence to the Cost Accounting plan. Its purpose is not only to ensure the arithmetic
accuracy of cost records but also to see the principles and rules have been applied correctly.

Financial Accounting
Financial Accounting is primarily concerned with the preparation of financial statements
(Balance Sheet, Profit & Loss Account), which summarise the results of operations for selected
period of time and show the financial position of the company at particular dates.
Financial Accounting is mainly concerned with requirements of creditors, shareholders,
government, prospective investors and persons outside the management. Financial
Accounting is mostly concerned with external reporting.

Financial Accounting Cost Accounting

(a) It provides the information about the
business in a general way. i.e. Profit and Loss
Account, Balance Sheet of the business to
owners and other outside partners.
(b) It classifies, records and analyses the
transactions in a subjective manner, i.e.
according to the nature of expense.
(c) It lays emphasis on recording aspect without
attaching any importance to control.
(d) It reports operating results and financial
position usually at the end of the year.
(a) It provides information to the management
for proper planning, operation, control and
decision making.
(b) It records the expenditure in an objective
manner, i.e. according to the purpose for which
the costs are incurred.
(c) It provides a detailed system of control for
materials, labour and overhead costs with the
help of standard costing and budgetary control.
(d) It gives information through cost reports to
management as and when desired.
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(e) Financial Accounts are accounts of the
whole business. They are independent in
nature.
(f) Financial Accounts records all the
commercial transactions of the business and
include all expenses i.e. Manufacturing, Office,
Selling etc.
(g) Financial Accounts are concerned with
external transactions i.e. transactions between
business concern and third party.
(h) Only transactions which can be measured in
monetary terms are recorded.
(i) Financial Accounting deals with actual figures
and facts only.
(j) Financial Accounting do not provide
information on efficiencies of various workers/
Plant & Machinery.
(k) Stocks are valued at Cost or Market price
whichever is lower.
(l) Financial Accounting is a positive science as it
is subject to legal rigidity with regarding to
preparation of financial statements.
(m) These accounts are kept in such a way to
meet the requirements of Companies Act 2013
as per Sec 128 & Income Tax Act, 1961 Sec
44AA.
(e) Cost Accounting is only a part of the
financial accounts and discloses profit or loss of
each product, job or service.
(f) Cost Accounting relates to transactions
connected with Manufacturing of goods and
services, means expenses which enter into
production.
(g) Cost Accounts are concerned with internal
transactions, which do not involve any cash
payment or receipt.
(h) Non-Monetary information likes No of Units
/ Hours etc are used.
(i) Cost Accounting deals with partly facts and
figures and partly estimates / standards.
(j) Cost Accounts provide valuable information
on the efficiencies of employees and Plant &
Machinery.
(k) Stocks are valued at Cost only.
(l) Cost Accounting is not only positive science
but also normative because it includes
techniques of budgetary control and standard
costing.
(m) Generally, Cost Accounts are kept
voluntarily to meet the requirements of the
management, only in some industries Cost
Accounting records are kept as per the
Companies Act.

Management Accounting
It is primarily concerned with management.
It involves application of appropriate techniques and concepts, which help management in
establishing a plan for reasonable economic objective.
Any workable concept or techniques whether it is drawn from Cost Accounting, Financial
Accounting, Economics, Mathematics and Statistics, can be used in Management
Accountancy.
Management Accountancy utilizes the principles and practices of Financial Accounting and
Cost Accounting in addition to other management techniques for efficient operations of a
company.
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It widely uses different techniques from various branches of knowledge like Statistics,
Mathematics, Economics, Laws and Psychology to assist the management in its task of
maximising profits or minimising losses.
The main thrust in Management Accountancy is towards determining policy and formulating
plans to achieve desired objective of management.
Management Accounting makes corporate planning and strategy effective.
From the above discussion we may conclude that the Cost Accounting and Management
Accounting are interdependent, greatly related and inseparable.

Management Accountant:
A Management Accountant accumulates, summarizes and analysis the available data and
presents it in relation to specific problems, decisions and day-to-day task of management.
A Management Accountant reviews all the decisions and analysis from management’s point
of view to determine how these decisions and analysis contribute to overall organizational
objectives.
A Management Accountant judges the relevance and adequacy of available data from
management’s point of view.

Elements of Cost:
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Direct Material Cost

Direct material cost can be defined as ‘The Cost of material which can be attributed to a cost
object in an economically feasible way’. Direct materials are those materials which can be
identified in the product and can be conveniently measured and directly charged to the
product. Thus, these materials directly enter the product and form a part of the finished
product.
For example, timber in furniture making, cloth in dress making, bricks in building a house.
The following are normally classified as direct materials:
(i) All raw materials, like jute in the manufacture of gunny bags, pig iron in foundry and fruits
in canning industry.
(ii) Materials specifically purchased for a specific job, process or order, like glue for book
binding, starch powder for dressing yarn.
(iii) Parts or components purchased or produced, like batteries for transistor-radios.
(iv) Primary packing materials like cartons, wrappings, card-board boxes, etc.

Indirect Material Cost

Materials, the costs of which cannot be directly attributed to a particular cost object.
Indirect materials are those materials which do not normally form a part of the finished
product. It has been defined as “materials which cannot be allocated but which can apportion
to or absorbed by cost centres or cost units”.
These are:
(i) Stores used in maintenance of machinery, buildings, etc., like lubricants, cotton waste,
bricks and cements.
(ii) Stores used by the service departments, i.e., non-productive departments like
Powerhouse, Boiler House and Canteen, etc., and
(iii) Materials which due to their cost being small, are not considered worthwhile to be treated
as direct materials.

Direct Labour / Employee Cost

The cost of employees which can be attributed to a cost object in an economically feasible
way.
In simple words, it is that labour which can be conveniently identified or attributed wholly to
a particular job, product or process or expended in converting raw materials into finished
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goods. Wages of such labour are known as direct wages. Thus, it includes payment made to
the following groups of labour:
(i) Labour engaged on the actual production of the product or in carrying out of an operation
or process.
(ii) Labour engaged in adding the manufacture by way of supervision, maintenance, tool
setting, transportation of material etc.
(iii) Inspectors, analysts etc., specially required for such production.

Indirect Labour/ Employee Cost

The labour / employee cost which cannot be directly attributed to a particular cost object.
The wages of that labour which cannot be allocated but which can be apportioned to or
absorbed by cost centres or cost units is known as Indirect Labour.
In other words, paid to labour which are employed other than on production constitute
indirect labour costs.
Example of such labour are charge-hands and supervisors; maintenance workers; men
employed in service departments, material handling and internal transport; apprentices,
trainees and instructors; clerical staff and labour employed in time office and security office.

Direct or Chargeable Expenses

Direct expenses are expenses relating to manufacture of a product or rendering a service
which can be identified or linked with the cost object other than direct material cost and
direct employee cost.
Direct expenses include all expenditure other than direct material or direct labour that is
specifically incurred for a particular product or process. Such expenses are charged directly
to the particular cost account concerned as part of the prime cost.
Examples of direct expenses are:
(i) Excise duty
(ii) Royalty
(iii) Architect or Supervisor’s fees
(iv) Cost of rectifying defective work
(v) Travelling expenses to the city
(vi) Experimental expenses of pilot projects
(vii) Expenses of designing or drawings of patterns or models
(viii) Repairs and maintenance of plant obtained on hire; and
(ix) Hire of special equipment obtained for a contract.
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Overhead
Overheads comprise of indirect materials, indirect employee cost and indirect expenses which
are not directly identifiable or allocable to a cost object.
Overheads may be defined as the aggregate of the cost of indirect material, indirect labour
and such other expenses including services as cannot conveniently be charged directly to
specific cost units.
Thus, overheads are all expenses other than direct expenses.
In general terms, overheads comprise all expenses incurred for or in connection with, the
general organization of the whole or part of the undertaking, i.e., the cost of operating
supplies and services used by the undertaking and includes the maintenance of capital assets.

Prime Cost
The aggregate of Direct Material, Direct Labour and Direct Expenses. Generally, it constitutes
50% to 80% of the total cost of the product, as such, as it is primary to the cost of the product
and called Prime Cost.

Cost Object
Cost object is the technical name for a product or a service, a project, a department or any
activity to which a cost relates.
Therefore, the term cost should always be linked with a cost object to be more meaningful.
Establishing a relevant cost object is very crucial for a sound costing system. The Cost object
could be defined broadly or narrowly.
At a broader level a cost object may be named as a Cost Centre, whereas at a lowermost level
it may be called as a Cost Unit.

Cost Centre
A cost centre as a location, a person, or an item of equipment (or a group of them) in or
connected with an undertaking, in relation to which costs ascertained and used for the
purpose of cost control.
Cost centres are of two types:
i. Personal Cost Centre - A personal cost centre consists of person or group of
persons.
ii. Impersonal Cost Centre - An impersonal cost centre consists of a location or item
of equipment or group of equipment.
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In a manufacturing concern, the cost centres generally follow the pattern or layout of the
departments or sections of the factory and accordingly,
There are two main types of cost centres as below:
(i) Production Cost Centre: These centres are engaged in production work i.e.
engaged in converting the raw material into finished product, for example
Machine shop, welding shops...etc.
(ii) Service Cost Centre: These centres are ancillary to and render service to
production cost centres, for example Plant Maintenance, Administration...etc.

The number of cost centres and the size of each vary from one undertaking to another and
are dependent upon the expenditure involved and the requirements of the management for
the purpose of control.

Responsibility Centre
A responsibility centre in Cost Accounting denotes a segment of a business organization for
the activities of which responsibility is assigned to a specific person.
Thus, a factory may be split into a number of centres and a supervisor is assigned with the
responsibility of each centre.
All costs relating to the centre are collected and the Manager responsible for such a cost
centres judged by reference to the activity levels achieved in relation to costs.
Even an individual machine may be treated as responsibility centre for cost control and cost
reduction.

Profit Centre
Profit centre is a segment of a business that is responsible for all the activities involved in the
production and sales of products, systems and services.
Thus, a profit centre encompasses both costs that it incurs and revenue that it generates.
Profit centres are created to delegate responsibility to individuals and measure their
performance.
In the concept of responsibility accounting, profit centres are sometimes also responsible for
the investment made for the centre.
The profit is related to the invested capital. Such a profit centre may also be termed as
investment centre.
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Cost Unit
Cost Unit is a device for the purpose of breaking up or separating costs into smaller sub-
divisions attributable to products or services.
Cost unit can be defined as a ‘Unit of product or service in relation to which costs are
ascertained’. The cost unit is the narrowest possible level of cost object.
It is the unit of quantity of product, service of time (or combination of these) in relation to
which costs may be ascertained or expressed.
We may, for instance, determine service cost per tonne of steel, per tonne-kilometre of a
transport service or per machine hour.
Sometimes, a single order or contract constitutes a cost unit which is known as a job. A batch
which consists of a group of identical items and maintains its identity through one or more
stages or production may also be taken as a cost unit.
A few examples of cost units are given below:

Industry / Product Cost Unit

Automobile Number of vehicles
Cable Metres / kilometres
Cement Tonne
Chemicals / Fertilizers Litre / Kilogram / tonne
Gas Cubic Metre
Power - Electricity Kilowatt Hour
Transport Tonne-Kilometre, Passenger-
Kilometre
Hospital Patient Day
Hotel Bed Night
Education Student year
Telecom Number of Calls
BPO Service Accounts handled
Professional Service Chargeable Hours

Cost Allocation
When items of cost are identifiable directly with some products or departments such costs
are charged to such cost centres. This process is known as cost allocation.
Wages paid to workers of service department can be allocated to the particular department.
Indirect materials used by a particular department can also be allocated to the department.
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Cost allocation calls for two basic factors –

(i) Concerned department/product should have caused the cost to be incurred, and
(ii) Exact amount of cost should be computable.

Cost Apportionment
When items of cost cannot directly charge to or accurately identifiable with any cost centres,
they are prorated or distributed amongst the cost centres on some predetermined basis. This
method is known as cost apportionment.
Thus, we see that items of indirect costs residual to the process of cost allocation are covered
by cost apportionment.
The predetermination of suitable basis of apportionment is very important and usually
following principles are adopted –
(i) Service or use
(ii) Survey method
(iii) Ability to bear.

The basis ultimately adopted should ensure an equitable share of common expenses for the
cost centres and the basis once adopted should be reviewed at periodic intervals to improve
upon the accuracy of apportionment.

Cost Absorption
Ultimately the indirect costs or overhead as they are commonly known, will have to be
distributed over the final products so that the charge is complete. This process is known as
cost absorption, meaning thereby that the costs absorbed by the production during the
period.
Usually any of the following methods are adopted for cost absorption –
(i) Direct Material Cost Percentage
(ii) Direct Labour Cost Percentage
(iii) Prime Cost Percentage
(iv) Direct Labour Hour Rate Method
(v) Machine Hour Rate, etc.

The basis should be selected after careful maximum accuracy of Cost Distribution to various
production units. The basis should be reviewed periodically and corrective action whatever
needed should be taken for improving upon the accuracy of the absorption.
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Conversion Cost
This term is defined as the sum of direct wages, direct expenses and overhead costs of
converting raw material to the finished products or converting a material from one stage of
production to another stage.
In other words, it means the total cost of producing an article less the cost of direct materials
used.
The cost of indirect materials and consumable stores are included in such cost. The
compilation of conversion cost is useful in a number of cases.
Where cost of direct materials is of fluctuating nature, conversion cost is used to cost control
purpose or for any other decision making.
In contracts/jobs where raw materials are on account of the buyer’s conversion cost takes the
place of total cost in the books of the producer. Periodic comparison/review of the conversion
cost may give sufficient insight as to the level of efficiency with which the production unit is
operating.

Cost Control
Cost Control is defined as the regulation by executive action of the costs of operating an
undertaking, particularly where such action is guided by Cost Accounting.
Cost control involves the following steps and covers the various facets of the management:
i. Planning:
First step in cost control is establishing plans / targets. The plan/target may be in the form of
budgets, standards, estimates and even past actual may be expressed in physical as well as
monetary terms. These serves as yardsticks by which the planned objective can be assessed.
ii. Communication:
The plan and the policy laid down by the management are made known to all those
responsible for carrying them out. Communication is established in two directions; directives
are issued by higher level of management to the lower level for compliance and the lower
level executives report performances to the higher level.
iii. Motivation:
The plan is given effect to and performances starts. The performance is evaluated, costs are
ascertained and information about results achieved are collected and reported. The fact that
costs are being complied for measuring performances acts as a motivating force and makes
individuals endeavor to better their performances.
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iv. Appraisal and Reporting:

The actual performance is compared with the predetermined plan and variances, i.e.
deviations from the plan are analysed as to their causes. The variances are reported to the
proper level of management.
v. Decision Making:
The variances are reviewed, and decisions taken. Corrective actions and remedial measures
or revision of the target, as required, are taken.

Advantages of Cost Control

The advantages of cost control are mainly as follows
(i) Achieving the expected return on capital employed by maximising or optimizing profit
(ii) Increase in productivity of the available resources
(iii) Reasonable price of the customers
(iv) Continued employment and job opportunity for the workers
(v) Economic use of limited resources of production
(vi) Increased credit worthiness
(vii) Prosperity and economic stability of the industry

Cost Reduction
Cost reduction would mean maximization of profits by reducing cost through economics and
savings in costs of manufacture, administration, selling and distribution.
Cost reduction may be defined as the real and permanent reduction in the unit costs of goods
manufactured or services rendered without impairing their suitability for the use intended.
As will be seen from the definition, the reduction in costs should be real and permanent.

Broadly speaking reduction in cost per unit of production may be affected in two ways viz.,
(i) By reducing expenditure, the volume of output remaining constant, and
(ii) By increasing productivity, i.e., by increasing volume of output and the level of expenditure
remains unchanged.
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Reductions due to windfalls, fortuities receipts, changes in government policy like reduction
in taxes or duties, or due to temporary measures taken for tiding over the financial difficulties
do not strictly come under the purview of cost reduction.
At the same time a programme of cost reduction should in no way affect the quality of the
products nor should it lower the standards of performance of the business.

Cost Control vs. Cost Reduction:

Both Cost Reduction and Cost Control are efficient tools of management, but their concepts
and procedure are widely different. The differences are summarised below:

Cost Control Cost Reduction

(a) Cost Control represents efforts made
towards achieving target or goal.
(b) The process of Cost Control is to set up a
target, ascertain the actual performance and
compare it with the target, investigate the
variances, and take remedial measures.
(c) Cost Control assumes the existence of
standards or norms which are not challenged.
(d) Cost Control is a preventive function. Costs
are optimized before they are incurred.
(e) Cost Control lacks dynamic approach.
(a) Cost Reduction represents the achievement
in reduction of cost.
(b) Cost Reduction is not concern with
maintenance of performance according to
standard.
(c) Cost Reduction assumes the existence of
concealed potential savings in standards or
norms which are therefore subjected to a
constant challenge with a view to improvement
by bringing out savings.
(d) Cost Reduction is a corrective function. It
operates even when an efficient cost control
system exists. There is room for reduction in
the achieved costs under controlled conditions.
(e) Cost Reduction is a continuous process of
analysis by various methods of all the factors
affecting costs, efforts and functions in an
organization. The main stress is upon the why
of a thing and the aim is to have continual
economy in costs.
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Techniques of Costing
1. Marginal Costing
2. Standard Costing
3. Budgetary Control
4. Uniform Costing

1. Marginal costing
Marginal Costing is the ascertainment of marginal costs and of the effect on profit of changes
in volume or type of output by differentiating between fixed costs and variable costs.
Several other terms in use like Direct Costing, Contributory Costing, Variable Costing,
Comparative Costing, Differential Costing and Incremental Costing are used more or less
synonymously with Marginal Costing.
The term direct cost should not be confused with direct costing. In absorption Costing, direct
cost refers to the cost which is attributable to a cost centre of cost unit (e.g., direct labour,
direct material and direct expenses including traceable fixed expenses, i.e., the fixed expense
which are directly chargeable).
In Direct Costing (or Marginal Costing), factory variable overhead is taken as a direct cost while
in the Absorption Cost Method, it is Indirect Cost.

2. Standard Costing
Standard Costing is defined as the preparation and use of standard cost, their comparison
with actual costs and the measurement and analysis of variances to their causes and points
of incidence.
Standard Cost is a predetermined cost unit that is calculated from the management’s
standards of efficient operation and the relevant necessary expenditure.
Standard Costs are useful for the cost estimation and price quotation and for indicating the
suitable cost allowances for products, process and operations but they are effective tools for
cost control only when compared with the actual costs of operation.
The techniques of standard costing may be summarised as follows:
(i) Predetermination of technical data related to production. i.e., details of materials and
labour operations required for each product, the quantum of inevitable losses, efficiencies
expected, level of activity, etc.
(ii) Predetermination of standard costs in full details under each element of cost, viz., labour,
material and overhead.
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(iii) Comparison of the actual performance and costs with the standards and working out the
variances, i.e., the differences between the actual and the standards.
(iv) Analysis of the variances in order to determine the reasons for deviations of actuals from
the standards.
(v) Presentation of information to the appropriate level of management to enable suitable
action (remedial measures or revision of the standard) being taken.

3. Budgetary Control
Budgetary Control may be defined as the process of continuous comparison of actual costs
and performance with the pre-established budgets in relation to the responsibilities of the
executives to the specific budgets for the achievement of a target in accordance with the
policy of the organisation and to provide a basis for revision of budget.
Therefore, Budgetary Control involves mainly establishment of budgets, continuous
comparison of actual with budgets for achievement of targets, revision of budgets in the light
of changed circumstances.
The classification of budgets into various categories certainly helps to make the budgetary
control more effective because the maximum use is made of the functional budgets.
Functional Budgets over the goals to be attained by the functional executives and thus assume
the greatest significance.

4. Uniform Costing
Uniform Costing may be defined as the application and use of the same costing principles and
procedures by different Organizations under the same management or on a common
understanding between members of an association.
It is thus not a separate technique or method.
It simply denotes a situation in which a number of organizations may use the same costing
principles in such a way as to produce costs which are of the maximum comparability.
From such comparable costs valuable conclusions can be drawn.
When the Uniform Costing is made use of by the different concerns the same management it
helps to indicate the strengths and/or weaknesses of those concerns. By studying the findings,
appropriate corrective steps may be taken to improve the overall efficiency of the
organizations.
When used by the member concerns of a trade association Uniform Costing helps to reduce
expenditure on a comparative marketing, to determine and follow a uniform pricing policy,
to exchange information between the members for comprised and improvement and so on.
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Methods or Types of Costing

Costing is the technique and process of ascertaining costs. In order to do the same, it is
necessary to follow a particular method of ascertaining cost.
Different methods of costing are applied to different industries depending upon the type of
manufacture and their nature. Broadly the costing methods are classified into the following:
(a) Specific Order Costing (Job or Terminal Costing)
(b) Operation Costing or Process or Period Costing

Specific Order Costing: Specific order costing is the category of basic costing methods
applicable where the work consists of separate jobs, batches or contracts each of which is
authorised by a specific order or contract.
It includes job costing consisting batch costing and contract costing.

1. Job Order Costing:

Industries which manufacture products or render services against specific orders as distinct
from continuous production for stock or sales use the job costing or job order method of cost
accounting.
The method is also known under various other names, such as specific order costing,
production order costing, job lot costing or lot costing.

Every order in job costing is separate and it is not essential that the same manufacturing
operations be carried out or the same materials be utilized in respect of each.
However, a number of identical orders or identical products may be combined together to
form lots or batches, each such lot or batch constituting a job order.
In the job costing system, an order or a unit, lot, or batch of a product may be taken as a cost
unit, i.e. a job.
In job costing, there is no averaging of costs except to the extent that in the ascertainment of
unit cost, the cost of a lot of products in one order is obtained. A job or an order may extend
to several accounting periods and job costs are, therefore, not related to particular periods.
Job costing is applicable to engineering concerns, construction companies, shipbuilding,
furniture making, hardware and machine manufacturing industries, repair shops, automobile
garages and several such other industries where jobs or orders can be kept separate.
Job cost accounting is followed in three types of manufacturing organisations:
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(i) Jobbing concerns.

(ii) Small firms.
(iii) Large enterprises manufacturing a variety of products.

2. Contract Costing:
Contract Costing or Terminal Costing as it is often termed, is a variant of the job costing
system, which is applied in businesses engaged in building or other construction work. The
jobs are usually the contracts entered into with the customers. As the number of such
contracts handled at a time by a business may not be usually large, Contract Costing is
comparatively simpler in operation than job costing system.
The basic principles applied in Contract Costing are the same as those used in job costing
except that these are modified to suit the particular requirements of the contracts.
Differences between Job costing and Contract costing:
(a) While the number of jobs in hand at any time in a concern may be large, only a few
contracts may be undertaken at a time.
(b) The accumulation, analysis, apportionment, allocation and control of costs is simplified in
Contract Costing.
(c) Most of the expenses are chargeable direct to the Contract Account. Direct allocation to
such an extent is not possible in job costing.
(d) As contracts may run for long periods, there arises the problem of assessment and
crediting of profits on incomplete contracts at the end of the accounting period.

Contract Costing is a type of costing used in constructional activities such as construction of

buildings, roads, bridges etc. The person who takes contract for a price is called the Contractor
and the person from whom it is taken is called the Contractee.
We are mainly concerned with the books of the contractor. To find out profit earned, or loss
incurred on the contract, the contractor prepares a nominal account in his books called
‘Contract Account’. In this account, all the expenses incurred by the contractor are debited
and the income i.e. mainly work certified is credited; the difference represents profit or loss.
The items generally debited are materials, wages, establishment expenses & other expenses.
Depreciation of assets used in the contract will also be debited, but unlike in other types of
accounts it is customary in Contract Accounts to debit the opening balance of the assets and
credit the closing balance of the same instead of depreciation, wherever it is convenient to
do so. Amounts credited are work-in-progress, which consists of work certified and cost of
work uncertified and any scrap of materials etc. Further some special items which are
discussed here under will also be taken care of.
Costing Free SEBI e-book

The contracts run for or number of years. However, it is necessary to find out the profit or
loss at the end of every year. The profit earned on a Contract Account is primarily called
Notional Profit and a portion of which would be kept on reserve against contingencies. The
profit to be transferred to Profit & Loss Account out of notional profit is ascertained by taking
into consideration the degree of completion of the work, cash received etc.

3. Process Costing
Process costing is that aspect of operation costing which is used to ascertain the cost of the
product at each process or stage of manufacture. This method of accounting used in
industries where the process of manufacture is divided into two or more processes. The
objective is to find out the total cost of the process and the unit cost of the process for each
and every process. Usually the industries where process costing used are textile, oil industries,
cement, pharmaceutical etc.
Features of Process Costing:
(a) Production is done having a continuous flow of products having a continuous flow of
identical products except where plant and machinery is shut down for repairs etc.
(b) Clearly defined process cost centres and the accumulation of all costs by the cost centres.
(c) The maintenance of accurate records of units and part units produced, and cost incurred
by each process.
(d) The finished product of one process becomes the raw material of the next process or
operation and so on until the final product is obtained.
(e) Avoidable and unavoidable losses usually arise at different stages of manufacture for
various reasons.
(f) In order to obtain accurate average costs, it is necessary to measure the production at
various stages of manufacture as all the input units may not be converted into finished goods.
(g) Different products with or without by-products are simultaneously produced at one or
more stages or processes of manufacture. The valuation of by-products and apportionment
of joint cost before joint of separation is an important aspect of this method of costing.
(h) Output is uniform, and all units are exactly identical during one or more processes. So the
cost per unit of production can be ascertained only by averaging the expenditure incurred
during a particular period.
Applications of Process Costing:
The industries in which process costs may be used are many. In fact, a process costing system
can usually be devised in all industries except where job, batch or unit or operation costing is
Costing Free SEBI e-book

necessary. In particular, the following are examples of industries where process costing is
applied:

Chemical works Textile, weaving, spinning

etc.
Soap making Food products
Box making Canning factory
Distillation process Coke works
Paper mills Paint, ink and varnishing
etc.
Biscuit works Meat products factory
Oil refining Milk dairy

Difference between Job Costing and Process Costing:

Job Costing Process Costing

The form of specific order That form of costing which

costing which applies where applies where standardised
the work is undertaken to goods are produced and
customer’s special production is in continuous
requirements. flow, the products being
homogeneous.
The job is the cost unit and Costs are collected by process
costs are collected for each job. or department on time basis
and divided by output for a
period to get an average cost
per unit.
Losses are generally not Normal losses are carefully
segregated. predetermined, and abnormal
losses are segregated.
Overheads are allocated and Units pass through the same
apportioned to cost centres processes. Overheads are
then absorbed by jobs, in apportioned to processes on
proportion to the time taken. some suitable basis,
sometimes, pre-determined
rates may be used
Joint products / By-products do Joint products/By-products do
not usually arise in jobbing arise, and joint cost
work. apportionment is necessary.
Standard costing is generally The standardised nature of
not suitable for jobbing work. products and processing
methods lends itself to the
adoption of standard costing.
Costing Free SEBI e-book

Work-in-progress valuation is For WIP valuation operating

specific and is obtained from costs have to be spread over
analysis of outstanding jobs. fully complete output and
partially complete products
using the concept of equivalent
units.
Each job is separate and Products lose their individual
independent of others. Costs identity as they are
are computed when a job is manufactured in a continuous
complete. flow. Costs are calculated at the
end of cost period.
There are usually no transfers Transfer of costs from one
from one job to another unless process to another is made, as
there is a surplus work or the product moves from one
excess production. process to another.
There may or may not be work- There is always some work-in-
in-progress at the beginning or process at the beginning as well
end of the accounting period. as at the end of the accounting
period.
Proper control is comparatively Proper control is comparatively
difficult as each product unit is easier, as the production is
different, and the production is standardised and is more
not continuous. stable.
It requires more forms and It requires few forms and less
details. details.

4. Operating or Service Costing

Cost Accounting has been traditionally associated with manufacturing companies. However
in the modern competitive market, cost accounting has been increasingly applied in service
industries like banks, insurance companies, transportation organizations, electricity
generating companies, hospitals, passenger transport and railways, hotels, road
maintenance, educational institutions, road lighting, canteens, port trusts and several other
service organizations. The costing method applied in these industries is known as ‘Operating
Costing’.
According to CIMA [London] operating costing is, ‘that form of operating costing which applies
where standardized services are provided either by an undertaking or by a service cost center
within an undertaking’.
Nature of Operating Costing:
The main objective of operating costing is to compute the cost of the services offered by the
organization.
Costing Free SEBI e-book

For doing this, it is necessary to decide the unit of cost in such cases.
The cost units vary from industry to industry.
For example, in goods transport industry, cost per ton kilometre is to be ascertained while in
case of passenger transport, cost per passenger kilometre is to be computed. Cost units used
in different service units are explained in detail later in chapter. The next step is to collect and
identify various costs under different headings.
The headings used are,
(a) Fixed or standing charges
(b) Semi-fixed or maintenance charges
(c) Variable or running charges.
One of the important features of operating costing is that mostly such costs are fixed in
nature. For example, in case of passenger transport organization, most of the costs are fixed
while few costs like diesel and oil are variable and dependent on the kilometres run.
Because of the diverse nature of activities carried out in service undertakings, the cost system
used is obviously different from that of manufacturing concern. Let us discuss the method of
computing costs in various service organisations.
This is all from us in this e-book for Costing. We hope that you could gain useful insights from
the contents of the e-book and go on to learn the concepts of costing useful for SEBI Grade A
exam.

The content of the e-book has been compiled from the study material of ICMAI.
You can go through the complete material here:
https://icmai.in/upload/Students/Syllabus2016/Inter/Paper-8-New.pdf
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